Technical analysis complements fundamental analysis by focusing more on numbers, patterns, and statistics, instead of the intrinsic value of an asset. Traders employ technical analysis to try to estimate future price behavior based on past trading performance and price movements rather than fundamental health, and typically do so by referring to patterns on an asset’s price chart. The idea behind technical analysis is that price trends themselves are a catalyst for future price trajectory, because history tends to repeat itself.
Any underlying asset that is sensitive to changes in supply and demand can be forecasted with technical analysis. Stocks, bonds, commodities and currencies are all the focus of technical analysts, who believe that price changes are never random, and that the reason for any small or large movement can be identified with the proper strategy.
Some popular technical indicators used for this trading methodology are found below:
- Moving Averages: Moving averages are a lagging indicator that can help illustrate to traders where the market is heading. The average price of an asset over different time periods is mapped onto the chart, showing broader trends and how they may intersect.
- Relative Strength Index: The RSI is a tool that indicates the momentum behind price movements of an asset. It can show how strong or weak a current trend is, and when conditions are ripe for a reversal in either direction.
- Fibonacci Retracements: Fibonacci retracements are technical indicators that demonstrate to traders where major support and resistance lines may appear. They can provide a good signal of where a trend might slow down, encounter more order activity, or reverse direction.
Of the two main types of analysis that traders engage in to inform their strategies, fundamental analysis takes a more qualitative approach as opposed to technical analysis. The goal of fundamental analysis is to find the intrinsic value of an asset, such as a stock, which can be attempted by looking at the company’s financial disclosures and other economic reports. This helps a trader determine the true health and sustainability of the company, regardless of what the charts look like.
Why Use Fundamental Analysis?
The point of fundamental analysis is to determine if a company is weak or strong within its industry and in general. If you determine from its key reports and other economic indicators that it is weak, considering a short position may be a smart strategy. The opposite is also true for fundamentally strong companies. Remember that fundamental analysis can be used to gauge the health of almost any underlying asset, not just stocks.
For instance, a trader can conduct fundamental analysis on a commodity by examining the economic conditions in those countries that represent its biggest source of production. Bond traders might look at broader economic components, interest rates and the credit rating of the bond issuer.
However, fundamental analysis is commonly associated with trading in the equity and foreign exchange markets. Traders have a lot of publicly available documents and other reports to analyze, including quarterly reports, debt, profits and revenues, future growth estimates and more, to try and get a picture of a company’s overall health.
Once a stock, currency, commodity, or index has been effectively analyzed, the idea is to arrive at its intrinsic, or true, value. If the intrinsic value of an asset is below the current market price, investors may opt to short the asset with the expectation that prices may fall to the intrinsic value with the passage of time. Similarly, if the intrinsic value of an asset exceeds the current market price, investors may elect to open a long position in anticipation of the asset rising in value.